- S&P-500 companies are finding it difficult to grow earnings, which is threatening the sustainability of dividends.
- Ford, an S&P-500 component, is also facing a challenging environment, but the situation is not alarming.
- Ford’s dividends are backed by one of the best free cash flow profiles in the industry.
A number of large-cap companies are finding it difficult to grow earnings, and that has raised concerns around the sustainability of dividends. That is compounding woes of income-seeking investors who are already facing a difficult time since interest rates have been near record lows for so long. But in this environment, Ford (NYSE:F) can prove to be a good investment.
The second quarter earnings season for the S&P-500 has almost come to an end. So far, 498 companies in the S&P-500 have reported their quarterly results and we’ve seen more than 3% decline in earnings per share, according to FactSet. The drops have been led by companies operating in the energy, materials, financial and industrial sectors. But what’s alarming is that the latest decline would be the first time since the global financial crisis that the index's earnings have fallen for five consecutive quarters. Moreover, analysts believe that the S&P-500 earnings would drop by 2.1% in the current year.
In an environment of shrinking earnings, companies will find it difficult to continue growing dividends. It’s not surprising, therefore, that in the first quarter of this year, the S&P-500 posted just 4.6% increase in dividends per share, which was the slowest growth in nearly six years. With declining earnings, the dividend growth will likely remain under pressure.
Dearborn, Michigan – based Ford was one of those S&P-500 companies that posted a decline in earnings in the second quarter when its profits fell by $0.05 to $0.49 per share. Ford is battling with weakness in US auto market where the company expects light vehicle sales will clock in at 17.1 million to 17.6 million units, as opposed to record of 17.5 million units last year. The Brexit vote could also weigh on Ford’s performance in Europe. Investors fear that Ford’s revenues and profits could move in-line with the US auto market which may have peaked last year and could decline in the coming years. The recently released sales report for the month of August was disappointing, with 8.4% drop in vehicle sales as compared to last year.
Not surprisingly, Ford stock has under-performed this year as compared to the broader S&P-500. The company’s shares have fallen almost 11% this year, as compared to S&P-500’s gain of 6.7%. Ford offers an attractive dividend yield of 4.8%, which is the highest in its peer group which includes General Motors (NYSE:GM), Fiat Chrysler (NYSE:FCAU), Honda (NYSE:HMC) and Toyota Motor Corp (NYSE:TM). Considering the tough macro backdrop, Ford’s above-average yield looks a bit risky, but a deeper look in the company reveals that it actually can be a great dividend stock.
Although the US auto market could shrink slightly this year and Ford’s namesake brand is struggling, the situation is not alarming. That’s because firstly, Ford is still optimistic about posting equal or higher pre-tax profit, automotive revenue, automotive operating margin and earnings per share in 2016 as compared to last year.
Secondly, the company has been reporting strong sales of trucks, vans, SUVs and Lincolns. That’s partially offsetting the negative impact of poor sales of other vehicles. Moreover, the increase in sales of high-end Lincolns and SUVs has also led to a $1,200 increase in average transaction pricing, allowing Ford to outperform the broader automotive industry in these terms.
More importantly, dividend investors should take respite in the fact that Ford continues to generate strong levels of cash flows that can easily fund its entire capital budget and dividends. In fact, in the second quarter, the company generated $4.2 billion in operating cash flows from the automotive business. Over the last twelve months, Ford has generated $20.38 billion of operating cash flows, which was enough to cover capital spending of $6.87 billion and dividends of $3.37 billion.
But that’s just the tip of the iceberg. Ford also has one of the best free cash flow (difference between operating cash flows and capital expenditure) profiles in the auto industry. Over the last twelve months, the company has generated free cash flows of around $3.38 per share, which is significantly higher than General Motor’s $1.75 per share. Moreover, Ford also comes with one of the best free cash flow yields in the industry of a little over 27%, significantly higher than the single-digit yields of its peers General Motors, Honda and Toyota.
Data source: Morningstar
The difference between FCF yield and dividend yield can be used to measure a company’s ability to grow dividends in the future. Generally speaking, bigger the difference, better the company is positioned to increase payouts. This puts Ford in an enviable position, as shown in the table above. The difference between Ford’s FCF yield and dividends is the highest in its peer group. In fact, Ford’s metric is also one of the highest among all S&P-500 companies.
A number of S&P-500 companies are struggling to grow earnings which have increased concerns around future dividend growth. But Ford, which is a part of S&P-500, believes that it can still grow its top and bottom-line. The company already gives an attractive yield of 4.8%. But more importantly, Ford generates enough cash flows to fully fund its capital expenditure and dividends and has one of the best free cash flow profiles in the industry. An analysis of the company’s FCF and dividend yields reveals that it has more headroom in terms of dividend growth than any of its peers. For these reasons, I believe Ford can be a great dividend stock.